Modern R&D Is Tech Service

At least in big corporations

This might be somewhat polarizing, but for the majority of chemical companies and related downstream companies R&D is a support function focused on maintaining cash flow and supporting sales to win new business. This may run counter to what many believe and I do believe that cutting edge, envelope pushing R&D exists at start-ups and some large chemical companies, but it’s never the full amount we might think when we look at a balance sheet.

The thing is R&D is a tax advantaged line item. Companies might target 3% of their revenue to go towards R&D and the story is that this money is being used to create growth. Some of that money does go to new product development, but the majority of it is just as a support function. Tax advantaged SG&A if you will.

If you know any scientists at big companies or even small companies with mature products ask them what they spend a lot of their time on. I bet many of them might say something to the effect of:

Well, I usually start of my day by handling a bunch of emails, doing some meetings, maybe I’ll go in the lab to work on troubleshooting some problems from the field. I’m working on some lower cost raw materials substitutions right now and I’ve got a green belt project I need to finish on making XYZ product more efficient. I’ve also got this growth project, but it’s not the majority of my time.

This is because when it comes time to report financial results to shareholders they are primarily concerned with revenue, volume, and profitability. Why take a risk on growth that might never materialize when you can make a slightly better product that might get one more customer at a slightly better margin? To quote Pacino in Any Given Sunday:

This is a game of inches

Shaving a few percentage points of cost off a raw material can have big cost savings at scale. A new product that is just slightly better than the current product might command a bit more profitability, gain additional sales, or it costs just a bit less to manufacture. Instead of spending 100% of R&D on big world changing research companies have decided the majority of this money should be spent on keeping the business running. If you are a securities analyst think about how that R&D money is spent and why.

Back in the day chemicals and plastics were the growth game and the companies that produced them were the growth companies, but things matured in the 1970s. Tsung Xu captures this well via production capacity growth in “A New Materials Paradigm is overdue”:

The early 20th century saw a veritable Cambrian Explosion of materials. Synthetic polymer production doubled every 2.5 years (at 31% CAGR) between 1911 and 1950 from 45 tons to 1.5 million tons. As their usage grew, costs came down and quality improved in a flywheel effect that opened up even larger markets. Note that since 1950, production has slowed down almost every decade. The 1950s saw a CAGR of 18.2%, whereas in the 2010s, it was 4.4% off a base that is two orders of magnitudes higher.

The markets where synthetic polymers and specialty chemicals could play got saturated. The productivity gains that these materials and chemicals promised were realized. Race to the bottom on costs then begins and this is the beginning of entrenchment and being beholden to your manufacturing capacity.

The reason synthetic polymers took off so quickly was because they were fixing needs that people didn’t think was possible. Replacing silk with nylon was huge. Replacing natural rubber with synthetic rubber was huge. Replacing polyester with a slightly better polyester? Meh. Eventually, spending a bunch of money on R&D to come up with growth products wasn’t as sure of a bet as it once was and we started to see declines in corporate R&D. Maybe the biggest indication of this was DuPont closing their central research division per Alex Tullo in C&EN:

DuPont Central R&D is one of the world’s oldest and most venerable corporate research organizations and has often been compared to the former Bell Labs. DuPont plunged into centralized, fundamental R&D in the 1920s under the guidance of Research Director Charles M. A. Stine. Stine hired Wallace H. Carothers away from Harvard University in 1928. Carothers’s work at DuPont would lead to neoprene and nylon.

DuPont’s labs even spawned a Nobel Laureate. DuPont chemist Charles J. Pedersen shared the 1987 Nobel Prize in Chemistry with Donald J. Cram and Jean-Marie Lehn for work in synthesizing macrocyclic polyethers, also known as crown ethers.

The layoffs at DuPont, which is a completely different company now, would take place between Christmas and New Years of 2015 in an effort to save $700 million. Alex Tullo for C&EN reported the story:

DuPont was vilified by many in the chemistry community for the maneuver, which was seen as a capitulation to Wall Street’s lust for short-term profits and a triumph of the suits over the lab coats. DuPont, many said, was eating the seed corn that would lead to tomorrow’s breakthrough products.

“Kevlar, to my understanding, took 20 years to get from the red to the black,” says Andrew Feiring, a chemist who was with CR&D from 1974 to 2006. “Wall Street just isn’t going to stand for that sort of thing today.”

The demise of CR&D may have been abrupt, but an astute company watcher might have seen it coming. Over the past two decades, CR&D has been evolving away from the exploratory research for which it is best known and toward science that addresses perceived needs of businesses such as electronic materials and industrial biotechnology.

I want to reiterate that last line from Tullo’s reporting because it gets to the heart of where large chemical companies have been going. R&D is there to address the needs of the business. That’s it. Support the business.

The idea that some corporate scientists in a lab could spend years working on basic research is for the most part gone (at least here in the US). Projects are either going to be supporting the business by defending existing business, tweaking an existing product to get new business, or cutting costs to make current business just a little bit more profitable. If you want to become a good project/product manager I think going up through a corporate R&D function is a good idea. If you want to work on cutting edge science it’s going to be “in your free time.” I think some European companies such as BASF or Evonik are still set-up to do long term basic research mainly because of labor laws which make it difficult to get rid of people.

I suspect that our current technology companies may also be going through the beginnings of this change as their products mature. Perhaps companies that are wholly composed of doing business in “bits” will get displaced by new entrants while those who have a footprint in the “atoms” will be harder to replace. It’s why I think we will still be using iPhones in twenty years, but perhaps Facebook will become synonymous with Geocities in the same time frame. It’s easier to scale bits and it’s more difficult to scale and/or replace atoms unless there are huge productivity gains.

Value Pull Through

If you are working on innovative new products and materials you might hear the phrase “value pull through.” If you haven’t heard it yet you should use it in your next meeting. You’re gonna sound smart.

This concept revolves around coming up with a new product, something that is marginally better than what you have now, and then figuring out how to use this product in customer applications. This happens in the coatings world all the time. If you are a raw material supplier to someone like Behr or PPG and you have a new material that could go into exterior architectural paint then you need to formulate and do the application testing yourself. You need to show value in the customer’s application with a sample formulation that you made with performance results tested against a few standards (ASTM, DIN, ISO, etc.). MAYBE your potential customer will take a sample of your product and test it themselves and if they find value they might start a project.

Another way to do this is to do all of your own application testing and then show your customer’s customer your data. Your customer’s customer gets excited and then asks their supplier, “hey, I need a product with this stuff.” Remember when I wrote that R&D supports the business?

Doing what your customers want is supporting the business. Predicting what your customers want is the job of marketing. Coming up with some new thing because you can do it does’t matter. Knowing how you’re going to make it, who you are going to sell it to, and how much more money you can make is what is important. Your job is to keep your plant full and make sure the margins get better. Everything in corporate R&D is about keeping your plant full and improving margins.

Chances are that if you are in corporate R&D a small portion of your time is dedicated to actual growth projects and the rest of your time is spent on technical service projects. Of the two large corporate R&D places (I’ve also been in small family run chemical company) where I’ve worked the system that kept track of project work had the words “Technical Service” in the title. If you are in corporate R&D you are in business of technical service.

If you are at a start-up then 100% of your time is spent on products aimed at growth because your company has no revenue.

Products Of The Future

When I think about synthetic polymers or modern materials I think about the inputs:

1. Crude Oil

2. Energy

Crude oil is how most of our synthetic polymers get made. Energy is what we used to distill, crack, and transform portions of crude oil into the synthetic polymers. Both of these inputs have variable costs, but the first is getting more scarce and the second is becoming more dangerous to produce through our traditional routes. This is why Dow is thinking about building a nuclear plant. Matt Blois for C&EN reported on the story and a key portion of it is here:

Dow and Shell are also testing electric cracking furnaces that could run on renewable power. Robert Kumpf, who focuses on the chemical industry as an executive at the consulting firm Deloitte, says such electric furnaces would operate 24 h a day, making it difficult to use intermittent energy sources like wind or solar. In contrast, nuclear power is available continuously.

Solar and wind with sufficient energy storage could also work, but I think we are still a few years away from having enough grid storage to meet this type of demand. It’s going to take some time for grid storage to be considered “good enough” to support business critical manufacturing capacity.

The other route in energy is to decrease the amount of energy that is needed. Catalysis (enzymatic, inorganic, and organometallic) will play a critical role in reducing total energy needed to transform chemicals and raw materials. I’ve written about this at length, but you can read about it here and here through the lens of start-ups.

Changing energy sources (away from natural gas or coal) and reducing overall needed energy is where we need to go and off-the-shelf solutions will get implemented first by large corporations. Start-ups will look to commercialize the riskier bets, but also stand to gain enormously from those gains if successful. If a start-up can produce XYZ monomer from crude oil with 50% less energy then there is an immediate cost savings that the company gets to capture as profit.

Another way to cost savings is to cut oil out from the supply chain. I’ve written about this concept here, but if the price of oil is $90/barrel and an equivalent volume of biomass is half the price or way lower the cost savings should start to become apparent. If the chemical/material from this cheaper raw material source is something that is currently made from crude oil then there is a big margin gain that is realized.

Synthetic biology might also hold promise here in utilizing both non-crude oil raw materials and low energy inputs. I’m betting that Danimer Scientific can commercialize PHAs into useful products, but operating in this space is tough because to bring that material to market Danimer needs to show tremendous value. If successful, Danimer will be utilizing both biomass and low energy inputs to displace something like polyethylene. If they can figure out the right path to profitability? 🚀

If you go into a room of investors and pitch your idea about how to save the world without telling them how you are going to make them a shitload of money it is not an investment you are pitching. It’s a charity. I think this is often what environmentalists get wrong (they are mostly half right). The best change engine we’ve figured out so far as a species is capitalism.

It’s tough for a large corporation to make risky bets under “R&D.” I suspect it has to do with financialization and a bunch of people with MBAs making Powerpoint decks and pivot tables in Excel. At best, true R&D is having about 70-80% of your chip stack in the pot on the flop in a game of no-limit hold-em' and you are still holding a pair of sixes with A, K, 7 showing on the table. To stay in the game you have to bet the last half of your remaining money.

Call and see the next card or fold and wait for a better hand?

Tony